Posts Tagged ‘Eurozone’

Santa Claus may be visiting Paris this Christmas, but it looks as though he’ll be dropping a lump of coal in President Sarkozy’s stocking, as reports are now widely circulating that Standard & Poors may issue a credit downgrade for the government of France in time for Christmas. In truth, this is no laughing matter, and it certainly portends ill tidings for the season, as the financial markets, already in turmoil over sovereign debt issues, and the imminent collapse of the Euro are on the verge of panic. Much like the downgrade that was issued for US government credit-worthiness, this seems to be bound to the failure to create a workable solution to the budgetary woes and general unsoundness of the fiscal policy of Eurozone member states.

In a report in the American Thinker on Friday, the details of the failure to attain a workable agreement for consolidation of fiscal policy among member states is outlined. According to that report, the rating agency Fitch is now considering downgrading Germany and other Eurozone members as they look at the increasing probability that no fiscal order will be brought into this situation.

This sets the stage for a new phase of the Eurozone crisis, where we may see the beginning of one-wide collapse. As I have reported in recent weeks, the looming catastrophe will have been due to two primary causes, and they are nearly impossible to overcome at this late date: The nations of Europe that created the single currency overstated the value of some of the previous currencies to an outrageous extent, meaning that the Euro was destined from the outset for failure. At the same time, there was no consolidation or enforcement of a unified fiscal policy for member states, so that those countries with already high debt ratios and generous welfare state benefits as well as remorselessly unconscionable retirement programs for government employees virtually guaranteed that there would be a collapse in some form. As with all such situations, government officials always seek one more postponement of the inevitable, but such a piper will not go unpaid.

What makes any and all of this relevant to we Americans is that our government and our Federal Reserve have tied us to the Euro to an extent that threatens to take us down with them. If the Euro goes, we will face some sort of financial calamity, and because some Euro derivatives have now been backed by FDIC, it places the American taxpayer on the hook should this all go belly-up. Add to this the trillions of dollars already loaned under the auspices of TARP and other bail-out programs administered by the Fed, and what you have is a scenario by which we are dragged down, cannibalized on behalf of our friends in Europe.

Our other increasing similarity to debt-ridden Europe is our debt-to-GDP ratio, all in the furtherance of the growing welfare state. During Barack Obama’s thirty-five months in office, we have added to our cumulative National Debt by something in the neighborhood of $4.5 trillion. For the first time in our nation’s history, debt now exceeds GDP. At this rate, we will soon exceed the likes of Italy, that has now a debt of more than 120% of GDP. At this point, the Obama administration in concert with the Federal Reserve is fighting the same sort of delaying tactic that the Eurozone is now employing: Prop everything up through just one more election. This is ever the tactic of politicians, who seek to maintain power in the face of calamities they have created. None of these heads of state are telling their people the truth, or preparing them for hardships that now loom in a very uncertain future. In part, they will offer that they do not wish to create undue panic, but in truth, they do not want to face their electorates’ anger.

Governments ought to have some responsibility to tell their people the truth, even when that truth is terrible and threatening. The actions of the Eurozone leaders are despicable to me for precisely this reason, because they are telling their people that it will be worked out, somehow, but by now, I think most people have begun to catch on, both in Europe and here at home. What politicians fear most is having to tell their electorate “no,” or worse, “no more.” Politicians rightly understand that through their relentless building of massive welfare states, they have created monsters that will soon threaten their creators. There’s a history of reprisals in Europe, and one can only hope it doesn’t come to that.

Reuters is reporting that the EU has effectively isolated Britain, and they way they tell it, it’s a disaster for Britain. From my point of view, it may lead to that country’s salvation. Insofar as I can determine, what happened may look like a British set-back according to Reuters, but for the life of me, I cannot see how. If British Prime Minister David Cameron were smart, he’d play this up, and seek to withdraw entirely from the Union. As the Reuters article makes clear, Britain has never been fully accepted by other EU members because they’ve neither joined the common currency nor accepted the Schengen Treaty that provides open borders between signatory nations. The assessment is that Cameron had been “constrained by domestic politics,” but I view that as a victory for the people of Britain. Rather than getting drawn even deeper into the quagmire of the EU, Britain may yet find itself able to maintain its sovereignty.

This is part of the problem the US faces with its Euro-entanglements. Also mentioned in the Reuters piece is the fact that US Treasury Secretary Tim Geithner was making his presence known during the flurry of meetings and negotiations happening across Europe throughout the week:

U.S. Treasury Secretary Timothy Geithner had spent several days in Europe before the summit. The United States, like all of Europe’s trade partners, had been watching the accelerating debt crisis with profound concern, worried for their own economies and banks.

No! This is the thing about which I have been warning you for some time, with the Euro currency teetering on the brink of total collapse: The United States has extended itself to cover Eurozone banks to an extent that is reckless and dangerous. Geithner was on hand to try to lend his assistance in shepherding the process along. In the end, what came out of it was what Sarkozy had wanted all along. There will be a new intergovernmental agreement among nations of the Eurozone as a sidebar to the main EU treaty. This effectively cuts Britain out, but it also gives Britain every justification in breaking all bonds with Brussels.

What is at stake is the notion of tying the budgets of EU nations to some sort of formal, centralized process, by means of which they hope to get control of the staggering debt. They have extended and leveraged and borrowed in every conceivable fashion, and yet they still look to do more. The single currency has been a problem even before its official beginning, since the manner in which it was created was based on some rather generous calculations of the value of the original members’ currencies, and because no budget discipline was installed at the time. Think of this as an incremental approach to a single central government for the entire zone.

In meetings with the head of the ECB, Mario Draghi, and euro zone finance ministers the conversation was all about the two-year-old debt crisis and how to resolve it. The issues: the role of the ECB, how far should or would it stand behind countries to buy them breathing space, the scale of the euro zone’s rescue fund, the part to be played by the IMF, and should the EU let private bondholders off the hook.

This should cause further concerns for Americans, because the IMF will get much of its funding from the US Federal Reserve, drawing the US even further into the Euro-debacle.

On Monday, Nicolas Sarkozy insisted that Britain is needed as part of the Eurozone trading bloc, but it’s hard to imagine how this remains that case, and Sarkozy admits as much, in stating:

“We did everything, the chancellor and I, to allow the British to take part in the agreement. But there are now clearly two Europes,” Sarkozy said in an interview with the French daily Le Monde.

This is a typically continental view of the issue, but it’s clear to me that Angela Merkel and Germany will bear the brunt of the strain. Nevertheless, it’s my view that as dire as some would like to make this out to be for Britain’s sake, I’m unmoved by their insistence that Prime Minister Cameron has made a mistake:

“I think that’s a shame because we need our British friends in Europe,” he said, arguing that Cameron’s centre-left predecessors Tony Blair and Gordon Brown would not have made “the same mistake”.

I think it was a terrible mistake for Britain to tie their nation to this mess in the first place, and I think that was true of Germany as well, but while the British have maintained some independence, the Germans have not, and now they will pay. If this all goes as badly as it seems that it may, Merkel and Sarkozy may be looking for non-extradition countries to which they can flee.

No, they aren’t really angry with us for opposing the new Treaty for Fiscal Union. The reason our brother and sister Europeans are so chronically enraged with the British is that we have been proved completely right about the euro. For more than 20 years, British ministers have been coming out to Brussels and saying that they just love all this single-market stuff, but that they doubt the wisdom of trying to create a monetary union. And for more than 20 years, some of us have been saying that the reason a monetary union won’t work is that you can’t do it without a political union – and that a political union is not democratically possible.

We warned that you would need a kind of central Euro-government to control national budgets and taxation, and that the peoples of Europe wouldn’t wear it. Now look. It wasn’t the Anglo-Saxon bankers who caused the trouble in the eurozone, Sarkozy mon ami. It was the utter failure of the eurozone countries – starting with France, incidentally – to observe the Maastricht rules. It was the refusal of the Greeks to control their spending or to reform their social security systems. In Greece and Italy, the democratic leaders have been effectively deposed in the hope of appeasing the markets and saving the euro; and what makes the leaders of the eurozone countries even more furious is that it doesn’t seem to be working.

Boris Johnson is absolutely right about this. It’s damned-well time somebody said it. Britain shouldn’t fear being cut out of Europe at this point. They should call it “Independence Day” and celebrate. In my view, the sooner they can dis-entangle themselves from the entire fiasco, the greater their chances of avoiding at least some of the calamity that will ruin the continent. I only wish our own leaders here in the US would do the same.

Note: In the US, by mid-afternoon Monday, the Dow was off more than 200 points, or roughly 1.7%, on fears about the continuing European crisis.

It’s possible that I could be wrong, but something about what’s happening in the economy leads me to suspect that despite the rosy prognostications of Government bureaucrats, and the even rosier hopes of some market analysts, I don’t think the improved GDP growth numbers for the third quarter are going to mean much for the long-term health of the economy. For one thing, the government has had to revise every quarter downward as they adjust their numbers to better fit reality. These first numbers are raw at best, and propaganda at worst, and may bear little or no resemblance to what is actually going on. For another thing, I’ve noticed a trend, and I suspect you’re going to notice it too. Fuel prices fell with the ugly end of summer, and they’ve recently begun to tick up anew. I suspect this will tell us the direction of the economy in two months or so, if history is a guide.

As I have discussed at length before, our economic prospects are linked to many things, but few are more important to growth than the price of energy. Through the first half of October, gasoline prices fell at the pump because the economy was doing poorly and producing few new businesses. By mid October, the price decline suddenly reversed and we watched the cost per gallon begin to tick upward again. As I have explained ad nauseum, once the prices tick back past the $3.50/gallon boundary on gasoline, or the $4.00 threshold on diesel, you can expect the temporary increase in growth we saw in the end of the 3rd quarter begin to be choked off.

There is always a lag to these things, but what should have offered you the tip on the economy’s underlying condition was when fuel prices began to decline well before Labor Day weekend. That’s a sign of a struggling economy, all else being equal, and it should have been noted with trepidation. I knew the numbers for August were going to be abysmal long before they eventuated. The price of fuel continued to slip, but some time in the last part of the third quarter, we saw a turnaround in growth. The reason is simple: With the prices of fuel in decline, economic activity increased, consumers had more to spend on other things, and we saw a brief uplift. I suspect that as this little bubble grows, the prices of fuels will follow. As they reach higher, they will begin to suck all of the oxygen out of the economic room, once again. When that happens, well, you know the rest.

At the same time all of this was going on, Texas was seeing record heat and a continuing drought(that persists for most of the state even now.) In that period, Texas began to experience rolling brown-outs, and threats of them, as our once enviable electrical grid could no longer support the demand. We’ve had to shut down a number of coal-fired power plants in Texas due to EPA regulations, and with no new plants to replace them, and more plant closures almost certain in the coming year, the prospects are going to worsen. Barack Obama’s obsession with the elimination of coal-fired plants is going to be the death of Texas, but hey, Texans didn’t elect him anyway, so why should he care? This political aspect aside, Rick Perry has been somewhat successful in getting some companies to relocate here, but they’ll find it difficult to function when they can’t turn the lights on.

At the end of it all, it was her superior understanding of this particular facet of the economy that had made me most hopeful Sarah Palin would run for president in 2012. Most politicians are blissfully ignorant of how thoroughly dependent growth is on energy. They will soon discover it if Obama has his way.

Now comes some very realistic analysis to which you should pay close attention. Despite all the assurances of impending improvement, and the ostensibly good news of last week’s Euro-deal, you should still prepare for all of that to collapse. As Liam Halligan reports in the Telegraph, this deal, this latest round of bail-outs offers not much hope of failure. As he rightly points out, with all of these government bail-outs, the natural signaling in the free-market is short-circuited, which means people take actions based on conditions that are largely ore even entirely artificial. It’s much like Treasury forcing all banks to take TARP money during the crisis of 2008, because they realized that by giving assistance funds to some banks, but not to others, they would be signaling which banks were in trouble. Rather than permit depositors to draw their own conclusions, and make rational choices, what they did was to intentionally obscure which banks were healthy and which were not. This sort of tinkering is part of what got us here from the outset.

Halligan’s basic warning boils down to a suggestion that the prideful Euro-set will not accept, but is nevertheless the best advice he could give them: Let Greece default, openly, and boot them from the Euro. Dump Portugal too, says Halligan, because as he points out, it is “absurd” to think of Portugal as having the same monetary stature as Germany. This is what you get when politicians interfere in the markets: Unbridled chaos and fakery, and this is what we are now experiencing. When the Euro-deal fails, as it almost certainly must, Wall Street and markets around the globe will lose all the value they’ve gained in recent weeks, and then some. Mr. Halligan concludes as follows:

“The eurocrats, of course, lack the guts to trim back monetary union to a more manageable size. Too much face would be lost. So “euroquake” fears, once viewed as outlandish, are gaining pace. Despite Thursday’s deal, and all the reassurances of a “durable solution”, the Italian government on Friday paid 6.06pc for 10-year money, up from just 5.86pc a month ago and a euro-era high. Such borrowing costs are disastrous, given that Rome must roll-over €300bn of its €1,900bn debt in 2012 alone. A default by Italy, the eurozone’s third-biggest economy, and the eighth-largest on earth, would make Lehman look like a picnic.”

“The eurozone must be consolidated. World leaders should similarly force European banks to disclose their losses, we all take the hit and then we move on. Instead, we are served-up, in ever more complex variants, the same “extend and pretend” non-solutions. It gives me no pleasure to write this, but I give this deal two weeks.”

Indeed, what Halligan predicts looks bleak, but as he reminds, it needn’t be the case. Just like in our own domestic policies, this is being done by people who are largely ignorant of the workings of markets and the conditions that drive them. The problem is, they always do what politicians have done since the first elections on record: They kick the can down the road hoping for one more postponement. There w ill come a day that such tactics will offer no further hedge, and I suspect it will be sooner rather than later.

Maybe the problem is that when Greenspan is actually in charge of something, he loses his competence. I don’t know. Back in the 1960s, he got it. Back when I was in diapers, this man exercised a fertile mind. Then, he was an unabashed advocate of capitalism and liberty. Somewhere on his way to becoming the chairman of the Federal Reserve, he lost his way. Now that he’s been out of there a while, it seems like he’s slowly coming back to his senses. He offered an in-depth analysis of the Euro Crisis, and I find it to be fairly close to the mark in most respects, but it also seems to be a scathing reproach to some of his own policies while he was the Chairman of the Federal Reserve system. In the end, however, he takes another step towards the failed policies in the US that Barack Obama is pursuing. Greenspan seems to have adopted statism, and while still occasionally correct, as often as not, he’s been tragically wrong.

His primary critique of the Euro goes back to it fundamental, underlying flaw: The cultures of Mediterranean Europe are vastly different from those of Central and Northern Europe. It’s much as I mentioned earlier when I described the debate I overheard among Germans in the late 1980s about the proposed European Union and a single unified currency: Germans viewed the southern Europeans with suspicion due to a long, long history of fiscal chicanery. Two decades have proven the point and Greenspan is now recognizing the fatal flaw those guesthouse discussions of two decades ago made plain to me at the time: Two distinct cultures and traditions cannot share a single currency, because one culture will tend to treat the currency and their fiscal responsibilities under the union with a higher level of diligence and respect than the other. Is there really any doubt but that this lies at the heart of the European crisis?

Of course, Greenspan is not the sort of fellow who will readily admit a mistake, and what he fails to mention in this critique of Europe is the extraordinarily loose monetary policy he himself administered over at the Federal Reserve. Frankly, between he and the hucksters of easy mortgage qualification, they together created a bubble of another sort that was likewise doomed to failure. You cannot build or center an economy on continuing growth in a housing market that is sabotaged by bad lending practices encouraged by your monetary policy, and your fiscal and regulatory policies besides. To see Greenspan make the one criticism without understanding his own role in the second is an irony of the most enlightening form.

In the end, however, Greenspan discusses the looming debt crisis in the US, and he seems now to be a budget hawk, but as ever, he is neutral to hostile on pro-growth fiscal policy. He believes in manipulating monetary policy to effect economic ends, so he sees no effective problem with massive tax hikes. This indifference, as much as anything else he said, demonstrates the coldly calculating view of individuals as a means to statist ends, and it is here that I suspect that Greenspan really hasn’t reformed much since departing the seat of Fed Chairman. At the end of the day, he still views your money and your life as instruments of the state, and his policy prescriptions fail to note a similar duality in cultures in our country, every bit as distinct and intractable as the differences between Northern and Southern Europe.

In our nation, the distinction isn’t formed along State borders, but at the split between urban and suburban/rural America. This also largely defines the political polarization he laments in Washington DC. It really is that obvious. Of course, I don’t expect Mr. Greenspan to notice this any more than he noticed the irony manifest in his criticism of the Eurozone. I also don’t expect him ever to make a full recovery to the days when he understood the moral root of money, when he wrote many intelligent articles in his youth. That was a long time ago, and it seems he has forgotten what he once knew. It’s one of the few areas in which I firmly agree with Ron Paul, although so many of his policy stances makes him unpalatable as a Presidential candidate. Still, I’d like to remind you of what Alan Greenspan once wrote, before he began to accept the premises of the statists. First published in Ayn Rand’s “Objectivist” newsletter in 1966, and subsequently reprinted in her book, Capitalism: The Unknown Ideal, in 1967:

Gold and Economic Freedom

by Alan Greenspan

An almost hysterical antagonism toward the gold standard is one issue which unites statists of all persuasions. They seem to sense — perhaps more clearly and subtly than many consistent defenders of laissez-faire — that gold and economic freedom are inseparable, that the gold standard is an instrument of laissez-faire and that each implies and requires the other.

In order to understand the source of their antagonism, it is necessary first to understand the specific role of gold in a free society.

Money is the common denominator of all economic transactions. It is that commodity which serves as a medium of exchange, is universally acceptable to all participants in an exchange economy as payment for their goods or services, and can, therefore, be used as a standard of market value and as a store of value, i.e., as a means of saving.

The existence of such a commodity is a precondition of a division of labor economy. If men did not have some commodity of objective value which was generally acceptable as money, they would have to resort to primitive barter or be forced to live on self-sufficient farms and forgo the inestimable advantages of specialization. If men had no means to store value, i.e., to save, neither long-range planning nor exchange would be possible.

What medium of exchange will be acceptable to all participants in an economy is not determined arbitrarily. First, the medium of exchange should be durable. In a primitive society of meager wealth, wheat might be sufficiently durable to serve as a medium, since all exchanges would occur only during and immediately after the harvest, leaving no value-surplus to store. But where store-of-value considerations are important, as they are in richer, more civilized societies, the medium of exchange must be a durable commodity, usually a metal. A metal is generally chosen because it is homogeneous and divisible: every unit is the same as every other and it can be blended or formed in any quantity. Precious jewels, for example, are neither homogeneous nor divisible. More important, the commodity chosen as a medium must be a luxury. Human desires for luxuries are unlimited and, therefore, luxury goods are always in demand and will always be acceptable. Wheat is a luxury in underfed civilizations, but not in a prosperous society. Cigarettes ordinarily would not serve as money, but they did in post-World War II Europe where they were considered a luxury. The term “luxury good” implies scarcity and high unit value. Having a high unit value, such a good is easily portable; for instance, an ounce of gold is worth a half-ton of pig iron.

In the early stages of a developing money economy, several media of exchange might be used, since a wide variety of commodities would fulfill the foregoing conditions. However, one of the commodities will gradually displace all others, by being more widely acceptable. Preferences on what to hold as a store of value will shift to the most widely acceptable commodity, which, in turn, will make it still more acceptable. The shift is progressive until that commodity becomes the sole medium of exchange. The use of a single medium is highly advantageous for the same reasons that a money economy is superior to a barter economy: it makes exchanges possible on an incalculably wider scale.

Whether the single medium is gold, silver, seashells, cattle, or tobacco is optional, depending on the context and development of a given economy. In fact, all have been employed, at various times, as media of exchange. Even in the present century, two major commodities, gold and silver, have been used as international media of exchange, with gold becoming the predominant one. Gold, having both artistic and functional uses and being relatively scarce, has significant advantages over all other media of exchange. Since the beginning of World War I, it has been virtually the sole international standard of exchange. If all goods and services were to be paid for in gold, large payments would be difficult to execute and this would tend to limit the extent of a society’s divisions of labor and specialization. Thus a logical extension of the creation of a medium of exchange is the development of a banking system and credit instruments (bank notes and deposits) which act as a substitute for, but are convertible into, gold.

A free banking system based on gold is able to extend credit and thus to create bank notes (currency) and deposits, according to the production requirements of the economy. Individual owners of gold are induced, by payments of interest, to deposit their gold in a bank (against which they can draw checks). But since it is rarely the case that all depositors want to withdraw all their gold at the same time, the banker need keep only a fraction of his total deposits in gold as reserves. This enables the banker to loan out more than the amount of his gold deposits (which means that he holds claims to gold rather than gold as security of his deposits). But the amount of loans which he can afford to make is not arbitrary: he has to gauge it in relation to his reserves and to the status of his investments.

When banks loan money to finance productive and profitable endeavors, the loans are paid off rapidly and bank credit continues to be generally available. But when the business ventures financed by bank credit are less profitable and slow to pay off, bankers soon find that their loans outstanding are excessive relative to their gold reserves, and they begin to curtail new lending, usually by charging higher interest rates. This tends to restrict the financing of new ventures and requires the existing borrowers to improve their profitability before they can obtain credit for further expansion. Thus, under the gold standard, a free banking system stands as the protector of an economy’s stability and balanced growth. When gold is accepted as the medium of exchange by most or all nations, an unhampered free international gold standard serves to foster a world-wide division of labor and the broadest international trade. Even though the units of exchange (the dollar, the pound, the franc, etc.) differ from country to country, when all are defined in terms of gold the economies of the different countries act as one — so long as there are no restraints on trade or on the movement of capital. Credit, interest rates, and prices tend to follow similar patterns in all countries. For example, if banks in one country extend credit too liberally, interest rates in that country will tend to fall, inducing depositors to shift their gold to higher-interest paying banks in other countries. This will immediately cause a shortage of bank reserves in the “easy money” country, inducing tighter credit standards and a return to competitively higher interest rates again.

A fully free banking system and fully consistent gold standard have not as yet been achieved. But prior to World War I, the banking system in the United States (and in most of the world) was based on gold and even though governments intervened occasionally, banking was more free than controlled. Periodically, as a result of overly rapid credit expansion, banks became loaned up to the limit of their gold reserves, interest rates rose sharply, new credit was cut off, and the economy went into a sharp, but short-lived recession. (Compared with the depressions of 1920 and 1932, the pre-World War I business declines were mild indeed.) It was limited gold reserves that stopped the unbalanced expansions of business activity, before they could develop into the post-World War I type of disaster. The readjustment periods were short and the economies quickly reestablished a sound basis to resume expansion.

But the process of cure was misdiagnosed as the disease: if shortage of bank reserves was causing a business decline — argued economic interventionists — why not find a way of supplying increased reserves to the banks so they never need be short! If banks can continue to loan money indefinitely — it was claimed — there need never be any slumps in business. And so the Federal Reserve System was organized in 1913. It consisted of twelve regional Federal Reserve banks nominally owned by private bankers, but in fact government sponsored, controlled, and supported. Credit extended by these banks is in practice (though not legally) backed by the taxing power of the federal government. Technically, we remained on the gold standard; individuals were still free to own gold, and gold continued to be used as bank reserves. But now, in addition to gold, credit extended by the Federal Reserve banks (“paper reserves”) could serve as legal tender to pay depositors.

When business in the United States underwent a mild contraction in 1927, the Federal Reserve created more paper reserves in the hope of forestalling any possible bank reserve shortage. More disastrous, however, was the Federal Reserve’s attempt to assist Great Britain who had been losing gold to us because the Bank of England refused to allow interest rates to rise when market forces dictated (it was politically unpalatable). The reasoning of the authorities involved was as follows: if the Federal Reserve pumped excessive paper reserves into American banks, interest rates in the United States would fall to a level comparable with those in Great Britain; this would act to stop Britain’s gold loss and avoid the political embarrassment of having to raise interest rates. The “Fed” succeeded; it stopped the gold loss, but it nearly destroyed the economies of the world, in the process. The excess credit which the Fed pumped into the economy spilled over into the stock market, triggering a fantastic speculative boom. Belatedly, Federal Reserve officials attempted to sop up the excess reserves and finally succeeded in braking the boom. But it was too late: by 1929 the speculative imbalances had become so overwhelming that the attempt precipitated a sharp retrenching and a consequent demoralizing of business confidence. As a result, the American economy collapsed. Great Britain fared even worse, and rather than absorb the full consequences of her previous folly, she abandoned the gold standard completely in 1931, tearing asunder what remained of the fabric of confidence and inducing a world-wide series of bank failures. The world economies plunged into the Great Depression of the 1930′s.

With a logic reminiscent of a generation earlier, statists argued that the gold standard was largely to blame for the credit debacle which led to the Great Depression. If the gold standard had not existed, they argued, Britain’s abandonment of gold payments in 1931 would not have caused the failure of banks all over the world. (The irony was that since 1913, we had been, not on a gold standard, but on what may be termed “a mixed gold standard”; yet it is gold that took the blame.) But the opposition to the gold standard in any form — from a growing number of welfare-state advocates — was prompted by a much subtler insight: the realization that the gold standard is incompatible with chronic deficit spending (the hallmark of the welfare state). Stripped of its academic jargon, the welfare state is nothing more than a mechanism by which governments confiscate the wealth of the productive members of a society to support a wide variety of welfare schemes. A substantial part of the confiscation is effected by taxation. But the welfare statists were quick to recognize that if they wished to retain political power, the amount of taxation had to be limited and they had to resort to programs of massive deficit spending, i.e., they had to borrow money, by issuing government bonds, to finance welfare expenditures on a large scale.

Under a gold standard, the amount of credit that an economy can support is determined by the economy’s tangible assets, since every credit instrument is ultimately a claim on some tangible asset. But government bonds are not backed by tangible wealth, only by the government’s promise to pay out of future tax revenues, and cannot easily be absorbed by the financial markets. A large volume of new government bonds can be sold to the public only at progressively higher interest rates. Thus, government deficit spending under a gold standard is severely limited. The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit. They have created paper reserves in the form of government bonds which — through a complex series of steps — the banks accept in place of tangible assets and treat as if they were an actual deposit, i.e., as the equivalent of what was formerly a deposit of gold. The holder of a government bond or of a bank deposit created by paper reserves believes that he has a valid claim on a real asset. But the fact is that there are now more claims outstanding than real assets. The law of supply and demand is not to be conned. As the supply of money (of claims) increases relative to the supply of tangible assets in the economy, prices must eventually rise. Thus the earnings saved by the productive members of the society lose value in terms of goods. When the economy’s books are finally balanced, one finds that this loss in value represents the goods purchased by the government for welfare or other purposes with the money proceeds of the government bonds financed by bank credit expansion.

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.

This is the shabby secret of the welfare statists’ tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists’ antagonism toward the gold standard.

Yes, once upon a time, Greenspan was a sensible man who found the statists detestable. Somewhere, he lost his way, and I wish he would remember his earlier positions that had been far more logical.